The UK smaller companies sector has suffered from significant challenges in recent years. Greater investment outflows have led to significant under-valuation of the stock market’s smaller fry.
However, UK small-caps continue to exhibit robust fundamentals. Many of these corporate ‘acorns’ have the potential to grow into the ‘mighty oaks’ of the future.
In this article, we outline why now could be an opportune moment to invest in UK small-caps. We also highlight some top-performing investment trusts and funds which offer exposure to the theme.
Finally, we look at some of the companies which provide finance to UK small and mid-cap businesses, as these could be another way to play the ‘acorn’ strategy.
Why invest now?
As a long-duration asset class, the small-cap sector typically underperforms when inflation spikes. Conversely, the asset class tends to benefit in a disinflationary environment. Falling interest rates have historically supported small-cap recoveries.
So, with the Bank of England lowering rates, this could be the right time to add small-cap exposure to portfolios. Research shows UK smaller companies have outperformed their large counterparts over the long-term.
That said, small-caps are riskier investments so funds are a good way for many investors to achieve diversified exposure.
Vehicles you can trust
Among the top-performing dedicated UK smaller companies trusts is Rockwood Strategic (RKW). Manager Richard Staveley has a ‘value’ investor mindset and focuses on cash flows.
The trust has delivered a 10-year share price total return of 393%. That’s the highest return in the Association of Investment Companies’ (AIC) UK Smaller Companies sector.
Staveley seeks out proven businesses and opportunities for strategic, operational or management change to unlock shareholder value.
Strong demand for the strategy is reflected in a 3% premium to net asset value (NAV). This premium has enabled Rockwood to issue new shares and grow the size of the company.
Urge to merge
Rockwood is concentrated around 25 holdings ranging from RM Group (RM.) and Restore (RST:AIM) to high-flying Filtronic (FTC). Staveley recently initiated a holding in Focusrite (TUNE:AIM), a manufacturer of audio interfaces, equipment and audio reproduction kit.
He observes ‘significant margin improvement potential’ at the firm, which services ‘large addressable markets’ and has ‘a depressed valuation relative to history’.
Next from a 10-year performance viewpoint is JPMorgan UK Small Cap Growth & Income (JUGI), which trades at a 4.3% NAV discount.
Managed by Katen Patel and Georgina Brittain, ‘JUGI’ takes a high-quality approach to identifying the best UK small-cap opportunities. With small-cap valuations towards the lower end of their historic range, elevated levels of takeover activity have boosted the fund’s NAV performance.
This upsurge in M&A has also enabled Patel and Brittain to ‘rotate the proceeds into a broad range of new opportunities, spanning both consumer and business-facing companies, and domestic and overseas earners’, says research house Kepler.
The AIC UK Smaller Companies sector’s third-best performer over 10 years is BlackRock Throgmorton (THRG), which plans to combine with stablemate BlackRock Smaller Companies (BRSC).
This merger is backed by US activist Saba, which has stakes in both funds.
The bulked-up BlackRock Smaller Companies will sport net assets of roughly £780 million and deliver ‘greater scale, liquidity and cost efficiencies’ to shareholders.
Top-performing UK small-cap investment trusts
| Trust | 10yr share price total return | Discount/Premium |
| Rockwood Strategic | 393% | +3% |
| JPMorgan UK Small-Cap Growth & Income | 196% | -4.3% |
| BlackRock Throgmorton | 156% | -9.4% |
| Rights & Issues | 146% | -15.6% |
| Aberforth Smaller Companies | 130% | -8.9 |
Source: The AIC
Open-ended options
Investors are also blessed with some outstanding options in the open-ended funds universe.
Among the top five-year performers in the Investment Association’s (IA) UK Smaller Companies sector is Fidelity UK Smaller Companies (B7VNMB1). Manager Jonathan Winton focuses on undervalued firms whose recovery potential is not yet recognised by the market.
Another value fund is Aberforth UK Small Companies (0007272), whose diversified portfolio is ranked first quartile over one, three and five years alike.
Shrewdie at Schroders
The sector’s leading 3-year performers include Schroder UK Smaller Companies (B76V7Z9). Managed by Andy Brough, this fund offers exposure to Croydon-based chemicals group Zotefoams (ZTF), online package holiday specialist On The Beach (OTB) and inkjet technology company Xaar (XAR).
Also meriting mention are Unicorn UK Smaller Companies (3178506) and WS Gresham House UK Micro Cap (BV9FYS8).
The former has holdings in engineer Goodwin (GDWN), flooring supplier James Halstead (JHD:AIM) and Mercia Asset Management (MERC).
The latter is a dedicated micro-caps fund. Top 10 holdings range from software solutions provider ActiveOpps (AOM:AIM) and fishing tackle retailer Angling Direct (ANG:AIM) to pharmaceutical data analytics play Diaceutics (DXRX:AIM).
Take a look at small lenders
Another way to invest in a diversified group of small-cap companies is to buy the firms which lend to them. Although the large high-street banks do support small businesses, it’s a tiny part of their overall revenue.
While small and mid-cap companies make up around half of UK GDP, less than 2% of their funding comes from big banks. Small bank and non-bank lenders play a major role in providing finance and working capital to growing companies.
Below we present four companies which are directly involved in helping small businesses. All are run by extremely experienced teams who are genuinely passionate about supporting UK smaller companies.
They all take a slightly different approach, and they cover a whole range of industries and solutions. As with all lenders they involve an above-average degree of risk, so investors need to do their own research.
Distribution Finance Capital Holdings (DFCH)
This AIM-listed company began life as a non-bank lender but in 2020 it gained full bank authorisation. Today it provides finance for a network of over 88 manufacturers and 1,300 dealers and distributors.
It specialises in providing structured loans to underserved, capital intensive retail sectors. DFCH has a much higher net interest margin than the big banks and low arrears thanks to its disciplined lending approach.
In H1 2025, new lending increased by £118 million of 17% to a record £828 million. At the same time, return on tangible equity, a key measure of profitability, rose from 10.5% to 11.3%.
Read more about the company here: https://www.dfcapital-investors.com/
Funding Circle Holdings (FCH)
FTSE 250 non-bank lender Funding Circle has been in business since 2010 and has lent £16 billion to date. It calculates in that time it has supported 110,000 small firms and contributed £7.2 billion to UK GDP.
Instead of funding its lending through deposits, it gets its backing from large institutions looking to diversify their income. For asset managers and others, exposure to small businesses is an ‘alternative’ asset class with attractive returns.
Funding Circle estimates the total addressable UK market for term loans is £84 billion. Meanwhile, the total market for small-company B2B payments is £1.3 trillion making it a huge opportunity for lenders.
Read more about the company here: https://corporate.fundingcircle.com/investors/
Mercia Asset Management (MERC)
AIM-listed Mercia operates yet another model in the world of small-business finance. The firm is a private market investment platform, providing capital through debt, property finance, venture capital and private equity.
As its name suggests, its main area of operations is in the north-east of the UK. It has 11 offices and a 120-strong team deploying capital directly, from early-stage businesses to M&A deals.
Mercia has so far deployed over £2 billion in capital through more than 5,000 private-market transactions. As well as investing directly, the firm runs two funds, one for private debt and one for property investments.
Read more about the company here: https://www.mercia.co.uk/for-shareholders/mercia-asset-management-plc/
Time Finance (TIME)
Also AIM-listed, Time is another non-bank lender but unusually it gets its backing from mainstream banks. As a ‘Tier 2’ lender, it is supported by NatWest (NWG), RBS, which is part of NatWest, and the British Business Bank.
Time provides Asset Finance or Invoice Finance, which free up companies’ working capital and are secured. It also offers secured loans as part of an asset-based facility.
Occasionally, where margins are too low, the amount is too big or too risky, it brokers deals on to other lenders. The firm has a loan book of over £235 million and a pre-tax profit margin of 23%.
Read more about the company here: https://investors.timefinance.com/
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